Part A: (8 Marks)

Dazin corporation is an unlevered firm. Recently, the company decided to expand its business. For this purpose, it would require a capital of $30 million. The company may raise the capital through equity financing, and for this reason, it must sell 2/3^rd of the equity stakes. However, this decision would dilute the firms ownership control. The firm does not want to lose control and, therefore, intends to keep fifty percent ownership.

Required:

1. Assume that the firm finances $20 million through borrowing; what percentage of equity would Dazin corporation need to sell to finance $10 million? (Assume that the firm operates in a perfect capital market) (4 Marks)
2. Calculate the smallest amount Dazin corporation can borrow to finance $30 million without losing ownership control (Assume that the firm operates in a perfect capital market). (4 Marks)

Part B: (4 Marks)

King corporation is an unlevered firm with a market worth of $20 million. Given the tax benefit of debt, the company is considering changing its existing capital structure by adding debt. For this purpose, it plans to issue a permanent debt of $ 2 million and use the proceeds to buy back the shares. The debt would be issued at an interest rate of 7 percent. The corporate tax rate is 40%.

Required:

1. What is the effect of the new capital structure on the value of the firm? (2 Marks)
2. What is the effect of the new capital structure on the remaining value of equity? (2 Marks)

Part C: (3 Marks)

Given its current leverage level, Ring Inc. is expected to have a net income of $9.5 million next year. If the company has a cost of debt of 8 Percent and has a 30 percent corporate tax rate, then how much additional debt can Ring Inc issue this year and still get the interest tax shield benefit next year? (3 Marks)